Which is bigger: the risk to China’s property market; or to the CCP’s reputation?

China’s central bank turned on the monetary taps, after property company Evergrande (dubbed the world’s most indebted developer) announced further difficulties in meeting its obligations.  The beleaguered company’s share price and credit rating plumbed new depths.

The company also informed the world that state representatives had taken a majority of seats on a new risk management committee.

It’s a splendid test case to see how communism with capitalist characteristics can manage market adjustment on a grand scale.

One suspects that quite a few people have confidence in the untrammelled powers of the Chinese Communist Party (CCP) to move markets.

But while this perception may raise the threshold for market panic, it also transfers the responsibility for distributing losses from market forces and bankruptcy courts to the party.  And this may have longer lasting and more far reaching impacts on confidence.

If the Chinese property and infrastructure market turns down further, the scale of the adjustment could be unprecedented.

Residential property comprises 70% of Chinese household wealth (compared to 35% in the US) according to Fortune magazine, while property and related activity contribute nearly 30% of GDP (also a much higher proportion than in the US).

Moreover, given the productivity gap between the two countries, China’s aggregate household wealth and wealth per head are both considerably lower than the US.

Nor do property prices in relation to the productivity (or incomes) of the people buying them look terribly encouraging.

Quite apart from the possible scale of the problem, there are two other specific issues to worry about.

The first is the legitimacy of the CCP in distributing losses. There will be a huge incentive to stiff foreign lenders.  Yet they surely believed they were lending to party-connected entities.  Their pain could push up the political risk premium for a long time.

The second is the lack of clarity on the true size and productivity of the state sector in China’s economy.  While some saw state industry as a source of strength in the era of strong private-led export growth, it might be more of a liability if it turns out that China’s managers and statisticians (under party guidance) were enthusiastic over-valuers, not least of property and infrastructure investment, during the boom time.

What China really needs to fill the gap is a rapid burst of export-led growth, more globalisation in short.  But unfortunately it is suffering a “surprisingly rapid slowdown” according to Morgan Stanley’s Ruchir Sharma:

“Beijing is locking down to contain the pandemic and cracking down on economically critical sectors and high corporate debt with an aggression unmatched by any other government.

And:

“China has been turning inward, replacing a growth model driven by trade to one driven by domestic consumers. Exports have fallen as a share of China’s GDP from above 35 per cent before 2010 to less than 20 per cent today.”

One result then:

“In the second quarter this year, China grew significantly slower than other emerging markets for the first time in three decades, which may be a sign of things to come.“

And those outward-looking and cosmopolitan entrepreneurs needed to provide the recovery, if state managers and housing developers come up short? Well, as Gideon Rachman points out in the FT, China’s elite  “tread a perilous path”.  The environment in which they operate has become even less like America’s and more like Russia’s.  It may not improve if the party finds itself struggling.

China is not disappearing as a global force just yet, but the foundations and sustainability of its rise look rather different than they did even a couple of years ago. And the credentials of the party as a prescient and efficient economic manager – incessantly talked up in recent years – look like they might take something of a hit.

The impact would be felt beyond China. One can’t help recalling how fears of Japan’s unstoppable rise during the 1980s peaked at about the same time as its economy fell off a cliff, ruining the career prospects for a generation of pundits.

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